Inefficiency and Misinformed Investment in Ethanol:
Arguing misunderstood scale efficiency and misallocated investment in domestic
ethanol production including an NIE treatment of vertical integration.
M. B. Scoll
12-18-07
Abstract:
Production of corn-based ethanol in the United States has driven unprecedented
investment in rural economies since the late 1990s. With the establishment of the
“renewable fuels mandate” in the President’s 2005 Energy Policy Act funding for
domestic production and a national market demand have stabilized. Currently the
industry is rolling-back investment plans and scaling down proposed developments and
expansions of existing plants. This paper uses a New Institutional Economic analysis to
explain how vertical integration benefits large production facilities. Further it reinforces
current arguments on the relative local impacts of these large production sites should they
come to dominate the industry. Proponents of corn ethanol argue that decentralized
domestic energy production can offset our energy insecurity from imported fossil fuels
while creating new demand for agricultural inputs improving local rural economies. The
paper shows the fallacies of these assumptions, namely that industry dynamics tend
towards large centralized production which minimizes relative local economic impact,
depresses input prices, and exacerbates rural instability by undercutting less costeffective but more socially beneficial producer-owned cooperatively organized ethanol
production.
Introduction:
Ethanol has been heralded as the most significant development in rural America
in the last quarter century (Urbanchuk, 2006). From under 175 million gallons in 1980,
domestic production has sky-rocketed to over 4.6 billion gallons annually. The most
recent Energy Policy Act of 2005 included the broadest incentives for biofuels yet,
including a federal mandate to require 7.5 billion gallons of renewable fuels such as
2
ethanol in the nation’s highway fuel supply by 2012 (Department of Energy, 2005).
Possible economic impacts range from reinvigorating rural economies to shrinking the
trade deficit. Agribusiness lobbyists highlighted, in 2005, the link between the 65% of
crude oil supply that was imported and the growing U.S. trade deficit. Estimates suggest
ethanol may offset 3.7 billion barrels of crude imports with domestic production by 2015.
The President’s 2005 Energy Policy Act mandated support for national output of
over 7.5billion gallons yearly. It is important to note that logistical limitations create
questions about actual demand. For now demand is stable due to the federal renewable
fuels mandate, beyond those 7.5 billion gallons projections for demand become less clear.
Many questions important to the development of ethanol markets remain unanswered.
Infrastructure constraints have the potential to limit development of this industry if not
addressed congruently with the expansion of the industry. Similarly ignoring the
potential for reaction by petroleum exporting countries and large transnational oil
companies is illogical. Their actions within the market are quite relevant to the
development of alternative fuels. As alternatives become cost effective competitive
pressure on these firms will increase, possible spurring reactionary limit pricing. Figure 1
illustrates the rapid growth of ethanol production.
3
Fig. 1 U.S. Ethanol Production (CARD, 2007)
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The potential for some economic impact from ethanol cannot be contested;
however the scale of that impact has been over asserted (Hendersen and Akers 2007).
The nature of ethanol production lends itself to certain production economies associated
with centralized, concentrated production. While some of these efficiencies are well
understood and reflected in investment and production development, continuing
investment trends in the ethanol market lead towards inefficiency. The scale of
investment in New Generation Cooperatives and small scale producers appears to
4
overlook inherent returns to scale associated with large capacity vertical integration and
industry concentrated.1 A New Institutional Economic approach to integration
efficiencies and transactions costs helps elucidate the cost-benefits of large scale
production.
In the U.S. there are 129 operational dry-mill ethanol plants with more in
development queuing (Urbanchuk, 2007). The ethanol industry in the U.S. is diversified
into three types of production facilities: small, privately-held, producer-owned firms,
cooperatives organized on a pay per bushel basis, and larger vertically integrated sites
that produce 100million gallons per year (MGY from now on). A single large
agribusiness firm operating vertically integrated plants, Archer Daniels Midland
Company (ADM) accounts for more than 1 billion gallons of annual domestic
production: four times any rival company (Swenson, 2006).
This paper argues that this diversity of production creates diverse benefits
reflective of the differing production schemes. Local impact measures of ownership in
ethanol production illustrate the economic effect of producer ownership, however public
opinion and the growing demand for energy independence incentivize large scale
centralized production. This paper explains the forces behind industry consolidation as
well as elucidating the local economic drawbacks of said consolidation. The question in
policy makers mind is not should we support domestic energy production, but rather does
our support promote the most socially beneficial means of production, or simply the most
cost-effective?
__________________________________________________________________
1.Production levels less than 30mgy million gallons per year roughly the average threshold for direct state
subsidization in the upper plain states. A majority of current and planned development is in 75 mgy or the
so called name-plate size for ethanol plants.
5
Figure 2 below illustrates the scope and diversity of the industry, while
production currently ranges across many states this paper will focus on the industry
trends of corn-belt states especially Iowa however the conclusions are broadly applicable.
Figure 2. Ethanol Development and Planned Expansion (Henderson, Akers 2006)
Energy issues are highly politicized especially the significant cost of foreign oil.
Public sensitivity to energy issues and resulting political culpability and public policy
have created conditions that misallocate resources in ethanol investment opportunities by
supporting temporary development of inefficient plants . Public support in the form of
tax incentives, loan guarantees, and tariffs on foreign competition all auspiciously aim to
promote small diversified production. Indeed literature indicates the largest relative local
economic impact is derived from local ownership (Urbanchuk, 2007.) Local ownership
of ethanol production creates a multiplier effect within regional economies (Urbanchuk,
2006). Local ownership is also a two-sided coin in that as the profitability of small
ethanol ventures decline as is likely with profit seeking entrants to the industry, high
6
levels of local exposure can create lasting negative economic impacts in rural economies
(Swenson, Eathingto 2006.)
Returns to scale and integration lead to a different outcome, namely absentee
ownership and off-sight administration. Local administrative and clerical services are
two areas where cooperative ownership increases local economic impact over
absenteeism (Urbanchuk, 2007). In the case of New Generation Cooperatives, members
control the prices they pay themselves per bushel of corn limiting the member-owners’
exposure to volatile commodity price fluctuations. Cooperatives additionally benefit
from the integration of supplying their own corn and chemical inputs like denaturants.
Increased external pressure on the logistics of the market from the high cost of
stainless steel rail cars and premium rail fares from greater demand threaten to bolster
entrenched operations while limiting new competition. Concentrated and integrated
ethanol production is more able to weather corn price shocks, overcome logistical
obstacles, benefit from internalizing transaction costs through integration, benefit from
scale economies in labor and capitalization, and capitalize on captive research and
development institutions such as Iowa’s Center for Agricultural and Rural Development
(CARD). These market conditions lend credence to the argument for concentration as an
efficient market decision; however it may not have the desired regional and local
economic payoff expected.
This paper argues that market forces dictate outcomes and efficiencies from larger
firms less likely to be locally owned. Volatility from new market demand and historically
unprecedented premium prices for inputs in ethanol production are creating an additional
burden for small producer owned cooperative ventures that are not diversified to weather
7
market fluctuations. Investors in New Generation Cooperatives (NGC) and medium
sized ventures ignore the competitiveness of strategic efficiencies from broad vertical
integration.2
Review of Literature
Integration within firms is a result of “transactional failures” from market
operations (Williamson, 1971). Market processes are internalized to substitute internal
solutions to market outcomes. In volatile commodity markets where weather and other
intangibles affect prices the advantages to internalizing input costs are evident.
Vertically integrated firms are not subject to ephemeral speculation or confidence of their
suppliers. Further, technological economies arise from the interdependency of successive
production processes and the logistical costs of ethanol dispersal. The realities of
internalizing transaction frictions promote largely concentrated production in contrast to
trends of decentralized investment and the plethora of small producer-owned and
cooperative ventures under construction (Swenson, 2006 p.19.)
Current government policy supporting ethanol must be rethought if the intent is to
create sustained decentralized rural economic stimulation. At this time, tax credits to
producers and tariffs on competition encourage a misallocation of investment funds to
ventures soon to lose competitiveness and feasibility. State-sponsored tax incentives
function ostensibly as incentives for entry by firms that are not viable as they would be
unable to compete unsubsidized with larger firms. Strategic use of integration can
achieve anticompetitive effects by substituting a firm’s will for a decision that is
otherwise subject to market coordination (Williamson, 1971.)
2. New Generational Cooperatives- agency premiums and dividends are paid on a per bushel of input basis in contrast to traditional
one member one vote organization. Similarly cooperative ownership of corporate ventures is a growing trend (Urbanchuk, 2006)
8
The specifics of current tax incentive structures will be analyzed to disambiguate their
effects on the current market structure, for now it is safe to assume that these price
supports alter the investment market in ethanol towards inefficient over-investment.
Iowa, the historical center of U.S. maize production, and now the epicenter of
ethanol development and research, is soon to become a net importer of corn (Swenson
and Eathington, 2006.) The paradox of how the nation’s single most fertile producer of
corn can come to import corn is linked to the story of ethanol and biofuel development.
In 2006 the U.S. supplanted Brazil as the largest ethanol producer in the world, producing
over 4.6 billion gallons. This juxtaposition is especially telling of the impact of recent
policy promoting ethanol production in the US since Brazilian sugar-cane ethanol is
cheaper and more efficient to produce in terms of externalities than corn-ethanol (Zhang,
Vedenov, Wetzstein, 2007.)
There was enormous public anticipation for this tide of ethanol especially in the
corn regions of the upper mid-west (Swenson, 2006). Proponents presuppose ethanol
will invigorate rural economies in the Midwest, stabilize certain commodity prices, but
most importantly it may provide a domestic salve to ease hypersensitivity to energy
concerns. There is a groundswell of support for domestic production of fuels, especially
those viewed as green (Urbanchuk, 2007.) Imported fuels have an implicit security cost
stemming from the volatility inherent in maintaining their supplies which is not reflected
in their market price; domestically supplied renewable fuels do not.
Why Now? Public Opinion’s Push.
“The world will soon start to run out of conventionally produced, cheap oil,”
begins the first chapter of David Goodstein’s Cassandran prediction in “Out of Gas” a
9
survival guide of the oil crisis. Books like Out of Gas, written in alarmist tones with
hosts of dire predictions have become part of the mainstream of public discourse.
Critics of our economies dependence on foreign fossil fuels argue that oil has an
ignored implicit security cost. The cost of ensuring global supply chains function
smoothly is paid to petroleum exporting countries in the form of a vulnerability premium.
A vulnerability premium is the cost from instability of supply that is inherent in the world
price, or the cost of globally stable supply-chains. Its incidence is the cost incurred in
military and economic intervention and aid predicated upon an importer-exporter
relationship. Since this cost is ignored by pricing schemes crude and vicariously highway
fuels, the world price and corresponding global quantity supplied exceeds the efficient
market allocation. This argument for domestic supply certainty is modeled in Figure 3.
10
This two period model illustrates the change in domestic output of petroleum as
foreign costs change, or the implicit foreign price changes due to global insecurity. The
shift from World Price up Foreign Supply is not reflected in the current global petroleum
market. While no one country can set the world price, changing world security
conditions should be illustrated by an increase in prices. Outputd represents the level of
domestic output in period one while the intersection of the blue foreign supply line with
the domestic supply line represents the output level of petroleum with the new world
price. The gap between quantity supplied and the demand curve is assumed to be the
amount imported. This graph illustrates the implicit price of secure supply chains. The
implicit cost of global security is implied but not reflected, the world price does not
adequately respond to account for the true economic cost of security.
The public outcry against the war in Iraq only increases public energy awareness.
“No blood for oil” and similar metaphors are popular rallying cries with anti-war activists
while pundit luminaries such as Alan Greenspan motivate the war with oil.2 Turbulence
in proximity to some of the world’s richest proven oil reserves and continued tension in
the Middle-East create anticipation in and support for domestic energy independence
regardless whether oil motivated intervention or was tertiary to political ends. Ethanol
producers continue to benefit from what critics of intervention in Iraq have called the war
for oil; as long as conflict continues producers will glean the benefits of direct and
indirect subsidies of public support and domestic preferences.
3
. Greenspan later retracted these statements citing deposing Saddam as having the largest impact on the
global economy, due to its liberalization of petroleum reserves. “He Said What?” Maggs, J, National
Journal, 9/22/2007
11
Figure 1 illustrated the dramatic increase in production since conflict began in 2003. The
potential for production has only grown with increased investment in the field. Political
support exists for further ethanol production in the name of energy independence; the
issue reemerged in the most recent farm-bill.
The scarcity of oil and the instability in securing our supply globally both impact
the price at which we consume oil. Ironically a byproduct of our consumption of the
fossil fuels we struggle over is global warming (Arrow, et al 2004.) The rapid change in
global climate norms caused by human actions especially burning of fossil fuels in first
world nations threatens to drastically alter the geo-political and physical landscape.
Global climate change is the third broadly applicable theme in public perception
incentivizing ethanol production. As a biofuel, the public perception of ethanol is as an
environmentally preferable alternative to gasoline with fewer negative environmental
impacts. That argument itself is highly contentious however the ramifications of support
from environmental advocates are tangible and apparent.
In 2004 and 2005 the domestic political atmosphere was ripe for an alternative to
Mid-East oil. Enter domestic ethanol producers and the agribusiness lobby.
Environmental critiques of ethanol note the scope of acreage necessary for ethanol to
completely supplant fossil fuel usage in the US. They argue the strain on marginal land
and even fertile land could have its own environmental cost as soil quality degrades
(Secchi & Babcock 2007.)
Political and Historical Context
Lobbying by agribusiness organizations such as the Clean Fuels Development
Coalition and Renewable Fuel Association has dramatically altered the political
12
landscape for ethanol producers in the last three decades. Agribusinesses like Archer
Daniels Midland (ADM) play a large role in the political development of ethanol
production due to its lobbying efforts and powerful political allies that once included
Senator Bob Dole and Former Vice President Hubert Humphrey (Runge and Senauer,
2007). Beginning with import restrictions in 1980 and culminating in the 2005 EPA
federal renewable fuel mandate, the 51cent tax credit per gallon, and the host of state
sponsored tax reductions all aim at spurring producer entry. Nationally the focus of
domestic production has created market inefficiency by limiting international competition
further encouraging early domestic entrants through inflated returns. The realities of
direct federal subsidies are more likely to limit the growth of producer owned plants such
as the New Generational Cooperative (NGC’s) which account for a large portion of
production in the upper plains states; instead promoting their cost-efficient competitors
(Holland, 2004).
Currently the federal government limits foreign competition in the ethanol market
with a 54 cent tariff on imported ethanol (Runge & Senauer 2007.) However with
Caribbean Basin Initiative, a trade agreement opening free-trade relations between the US
and host of Caribbean countries, duty free trade zones will overlap allowing cheaper
more efficient Brazilian ethanol duty free access to US markets. Figures 4 illustrates the
potential of this foreign competition. Earlier the volatility of security from domestic fuel
supply was modeled; this volatility premium serves as incentive for legislators to
maintain that tariff. Indeed there is a movement within Congress in conjunction with
increasing loan guarantees to ethanol to maintain the tariff (Runge, Senauer 2007.)
13
Figure 4 Brazilian Ethanol Production Projections (CARD 2007)
million gallons
8000
7000
6000
5000
4000
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Brazil
It is important to note that Brazilian ethanol has the inherent comparative
advantage of being both cheaper to produce (directly from sugar rather than corn mash to
sugars) and environmentally lower impact, or relatively regulated (Zhang et al, 2007.).
Ethanol proponents are caught in a catch-22 dilemma wherein the most environmentally
sound ethanol is not the most economically beneficial on a local scale. The current
political atmosphere seems unwilling to recognize this trade-off.
The impetus exist for a transition to low-cost production, however the market has
yet to adjust. This begs the question of why; where does this resistance to market
outcomes come from? Opponents of ethanol cite three key forces, first is the political
resistance to the change. As earlier noted the current state of the ethanol industry owes
itself largely to the political power of its proponents in Congress. This political will
stems from the diversity of the industry across rural America and is interrelated with a
second factor resisting change, the agency of farm organizations. Farm lobbying groups
14
have a disproportionate voice in national politics relative to their portion of the
population.
While only a small percentage of Americans still make their primary income in
agriculture, America continues is long political history of protectionist policies which
effect aggregate social wellbeing. This is evidenced in the 54cent tariff on cost-effective
Brazilian ethanol and its ramifications for the domestic ethanol industry. The
continuance of this tariff illustrates the third factor slowing transition to low-cost
production, especially in Brazil, which is the disharmony and lack of political agency that
competing producers display. The inability of Brazil’s ethanol industry to present a
unified political voice has limited its efficiency at combating protectionist policies in the
US and EU. This has impacted both the price here in the US of ethanol and the future
potential for development of the industry in Brazil (Zhang, et al 2007.) Supporters of
corn-ethanol in the US argue that the current positive economic and environmental
impacts outweigh the risk of a low-cost seeking market transition to imports of Brazilian
sugar cane ethanol. Next the specifics of those impacts will be made clear in an effort to
elucidate the impetus of resisting market reform.
Ethanol’s Impact
Policy makers are reluctant to liberalize ethanol trade because the majority of
economic literature focusing on the ethanol market highlights its impact on rural
economies (Swensen, 2007 p. 19-20). Table 1 models two sizes of ethanol plants and
their independent economic impacts. The impact of a plant in a rural economy goes
beyond simply the inputs to include transportation, construction, clerical, administrative,
and spill-over multiplier impacts (Swenson, 2006 ) Some of these multipliers include
15
dividends and premiums paid to local producers, spill over effects of infrastructure
development and technical training.
While these impacts are difficult to quantify, Table 1 also fails to quantify
negative externalities of production including higher feed costs, increases in staple grain
prices, increased strain on marginal land and increased strain on local infrastructure.
Urbanchuk also fails to address the risk associated with greater exposure of local
economies as farmers increase personal private debt to invest in ethanol ventures.
Table 1. (Urbanchuk, 2006)
Annual Expenditures
Gross Output
Gross State Output
Household Income
Newly Created Jobs
50MGY (2005$)
$46.7
$209.2
$115
$29.7
836 (real#)
100MGY (2005$)
$88.2
$406.2
$223.4
$51.2
1573 (real#)
If the previously mentioned positive externalities associated with ethanol
production indeed exist, they are offset or lost in cases of absentee ownership.
It
illustrates an intuitive convention that more money realized and re-spent locally is locally
beneficial (Swenson, Eathington 2006.) Unfortunately for local investment groups such
as New Generation Cooperatives, concentration trends and scale economies in the
industry threaten to undermine local ownership unless policy-makers take action to
artificially support the market. While existing subsidies maintain local ownership of
small scale production facilities Brazilian entry or a decline in the price of oil could
unbalance the market. Table 2 compares local ownership to absentee ownership as
typical in a public concern or traded company.
Table 2. Comparing Local and Absentee Ownership Impact Differentials
(Urbanchuk 2006)
16
Expenditures
(millions $2006)
Feedstocks
Chemicals,
Enzymes
Natural Gas
Electricity
Denaturants
Water
Direct Labor
Maintenance
Gross State Product
Interest on Debt
Total Expenditure
Absentee
Ownership
$40.18
$0.00
Farmer or Local
Ownership (NGC)
$40.18
$0.66
Difference in 2006$
$.66
$15.23
$2.31
$3.00
$.37
$1.60
$1.30
$1.50
$0.00
65.49
$15.23
$2.31
$3.00
$.37
$1.60
$1.30
$3.00
$2.43
70.09
$1.50
$2.43
$4.59million
The difference in expenditures between ownership patterns equate to millions of
dollars of difference per plant in an industry with over 120 plants, the resulting localized
impacts potentially lost from further centralization are in the $1.3-2 billion range
annually. Analysis of local ownership results in greater economic impact due to the
multiplier effect of locally held debt and expenditures on local inputs including chemical
and feedstock inputs (Swenson, Eathington 2006.) Table 2 leads to the conclusion that
the ideal industry is locally owned while table 1 illustrates relative decrease in jobs
created and GSP as plants centralize and expand beyond 50mgy in output.
NIE Approach to Vertical Integration
New institutional economists concern themselves with the conditions of market
failure where outcomes are not the most socially beneficial, and the resulting social
institutions which remedy that market failure. A NIE analysis of the efficiencies of
vertical integration in ethanol production will help evidence the potential for
concentration and consolidation in the ethanol industry. Ethanol is a declining cost
industry primarily because the three largest costs associated with it electricity, natural
gas, and corn all decline (Swenson, 2006.) The marginal outcomes of larger plants have
17
smaller impacts on local economies, further they have smaller multiplier effects because
the money paid for their product does not recycle locally. Additionally NGC and other
locally owned ventures often pay premium rates for inputs or value added prices for their
corn because they buy it from themselves, and secondly pay profits derived from ethanol
out in dividends and shared equity (Swenson, Eathington 2006.) Modeling the stream of
value added benefits is difficult but it can be asserted that these local economies
incidence is roughly equal to the savings in transportation and transaction costs of the
producers selling in a distant market (Swenson, 2006.)
Firms can achieve anti-competitive results by imposing their will through
integration rather than accepting market outcomes (Williamson, 1971.) In the ethanol
market efficiencies exist such as minimizing transaction and transport cost by purchasing
inputs from yourself or a subsidiary. The level of integration achievable in ethanol
production is especially interesting when the diversity of some companies in question is
considered. ADM for example sells its genetically proprietary seeds, purchases the
products of those seed sales from contracted producers around the country, processes the
corn in wholly owned production facilities and uses its extensive international
transportation network to market its ethanol.
Throughout its supply chain ADM and similarly scaled firms are able to take
advantage of scale economies. In purchasing corn from producers ADM is able to draw
on larger regional markets than local cooperatives and producer owned ventures. This
has two efficiencies. First ADM supersedes regional price variations from adverse
weather or other shocks. Second it is able to purchase at discounted rates because it
makes purchases on a much larger contractual basis (Swenson, 2006.) Locally and
18
producer owned firms have a slight efficiency in their guarantee of delivery and lack of
frictions in transport providing them a small efficiency from certainty of delivery and
intimate knowledge of their supply stocks. Knowledge and control of supply stocks and
their necessary levels internalizes market outcomes for inputs and creates cost-savings
from avoiding larger than needed overhead (Williamson, 1971.)
Large firms have the added asset of in-house administrative, clerical and human
resource operations which benefit from experience and integration (Urbanchuk, 2006.)
These jobs are one of the impact multipliers of local ownership; however local services
are often less efficient and more costly. Further, large firms control search costs for new
employees by handling promotions internally, in cases of expansion this can be a
significant administrative cost (Urbanchuk, 2006.) In contrast a new locally owned firm
will have to look outside its pool of producer owners to find a professional administrator.
Additionally the opportunity cost of a professional to seek employment at a NGC or
producer owned venture is great because the opportunity for promotion within the
company or cooperative is minimal or non-existent. Large firms are able to offer
promotional incentives beyond the local posting.
The final but arguably greatest scale economy for large firms is their control of
distribution and transportation infrastructure. The global demand for stainless steel, a key
component in the corrosion resistant tanker cars necessary to transport ethanol has been
increasing steadily driving up the global price (Liebman, 2006.) The demand for these
tankers has outstripped supply and the rapid depreciation of the cars is threatening to
increase that demand additionally. Large firms are able to independently negotiate orders
19
and purchases from the manufacturers ensuring a steady supply and an uninterrupted
delivery.
Conclusions
Deleted: <sp>
The growth of the domestic ethanol industry over the last three decades has
significantly altered the face of the rural economy in the U.S. The potential exists for this
industry to further develop as public demand for domestically produced sustainable fuels
grows. Public support for green fuels and local economies has created a glut of
investment in ethanol production that ignores the fundamental nature of the industry.
Recent investment trends ignore returns to scale from size and vertical integration. A
NIE approach to vertical integration illustrates how transaction costs and search costs are
reduced from scale efficiencies in the ethanol market. These scale efficiencies are absent
in the most economically beneficial scale of production, the locally or cooperatively
owned plant.
The results of the ethanol investment glut have only begun to be realized. While
locally higher corn prices may result in a booming rural economy, there are global
implications for basic food prices which condemn ADM’s self-styled “supermarket to the
world,” analogy (Runge and Senauer, 2007). The environmental impacts to the quality of
top-soil and watersheds from growing the 40 million tons of corn for ethanol have yet to
be gauged. That damage is further likely to be expounded should President Bush’s
urgings for 35 billion gallons of production by 2017 be met. Additionally ethanol
demand is seen as a grave threat to the Conservation Reserve Program a land trust for
sensitive soils retired from agriculture, with increasing premiums the opportunity costs of
keeping low yield acreage out of production grows.
20
Deleted: <sp><sp><sp>
Scarce public funds should not be spent on an untried industry whose investment
ideology is based on inflated expectations for growth and demand growth. Exaggerated
returns and benefits coupled with a decided lack of risk mediation and increasing external
capital investment are clouding the investment environment. While investment continues
to be led by producer owned cooperatives and vertically integrated medium sized
commodity producers, the fundamental underpinnings of the market broadly favor large
end-point producers who are able to overcome logistical obstacles and premium corn
prices through scale. By tracing the stream of economic benefits and following
consolidation trends it seems evident that current ethanol policy benefits the same
massive conglomerate agribusinesses that led the get big or get out movement in
American agriculture. It is tragically ironic that policies which benefit these companies
are encouraging small farmers and cooperatives to risk greater market exposure and
encure greater personal debt.
Deleted: <sp>
Misinformation and ignorance of market forces have created an atmosphere of
investment that is overly optimistic. Large producers benefit from control of
infrastructure, minimal transaction costs from internalizing market outcomes, and limited
search costs from returns to scale in administrative and clerical services as well as input
procurement contracts. However, public policy vocally aims to promote small-local
investment rather than the low-cost producer due to the specific economic impact of
small ventures. This industry pluralism exacerbate rural instability rather than
guaranteeing it. By draining investment capital out of tenuous rural economies into joint
ventures that in all likelihood will become non-competitive due to economies of scale
21
induced consolidation or foreign competition driving down profits current ethanol
policy’s means undercut its ends.
Today’s ethanol industry cannot continue to invest and expand at its current rate.
The growth of the industry is already constrained by infrastructure and input price
limitations. The most socially beneficial producers face the greatest risk of consolidation
while the least socially beneficial stand to benefit from misguided but well-intentioned
policy and potential changes in that policy which further their market position.
Continuing public support of ethanol should be tempered by the realistic impact of that
support, if in fact more cost effective ethanol is the desired result, then current trends of
consolidation are correctly pursued. If a locally produced sustainable alternative to oil is
the desired outcome then policy changes must be made to reflect the value of a secure
diversified industry and locally owned production.
22
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